Earnings Management and the Quality of Financial Reporting
Case Descriptions
Case # Case Name/Description
1-1 Harvard Cheating Scandal Student cheating at Harvard raises questions about responsibilities of instructors and student personal responsibilities
1-2 Giles and Regas Dating relationship between employees of a CPA firm jeopardizes completion of the audit.
1-3 NYC Subway Death: Bystander Effect or Moral Blindness Real-life situation where onlookers did nothing while a man was pushed to his death off a subway platform.
1-4 Lone Star School District Failure to produce documents to support travel expenditures raises questions about the justifiability of reimbursement claims.
1-5 Reneging on a Promise Ethical dilemma of a student who receives an offer of employment from a firm that he wants to work for, but only after accepting an offer from another firm.
1-6 Capitalization versus Expensing Ethical obligations of a controller when pressured by the CFO to capitalize costs that should be expensed.
1-7 Eating Time Ethical considerations of a new auditor who is asked to cut down on the amount of time that he takes to complete audit work.
1-8 A Faulty Budget Ethical and professional responsibilities of an accountant after discovering an error in his sales budget.
1-9 Cleveland Custom Cabinets Ethical and professional responsibilities of an accountant who is asked to “tweak” overhead to improve reported earnings.
1-10 Telecommunications, Inc. Concerns about the ethics of engineers who accept free travel and lodging from a foreign entity after establishing the criteria for a contract awarded to that entity.
Case # Case Name/Description
2-1 WorldCom Persistence of internal auditor, Cynthia Cooper, to correct accounting fraud and implications for Betty Vinson, a midlevel accountant, who went along with the fraud
2-2 Better Boston Beans Conflict between wanting to do the right thing and a confidentiality obligation to a coworker.
2-3 The Tax Return Tax accountant’s ethical dilemma when asked by her supervisor to ignore reportable lottery winnings.
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2-4 Shifty Industries Depreciation calculations and cash outflow considerations in a tax engagement.
2-5 Blues Brothers Identifying enablers and disablers of ethical action and ways to convince others of one’s point of view.
2-6 Supreme Designs, Inc. Ethical dilemma of an accountant who uncovers questionable payments to his supervisor.
2-7 Milton Manufacturing Company Dilemma for top management on how best to deal with a plant manager who violated company policy but at the same time saved it $1.5 million.
2-8 Juggyfroot Pressure imposed by a CEO on external accountants to change financial statement classification of investments in securities to report a market gain in earnings.
2-9 Phar-Mor SEC investigation of Phar-Mor for overstating inventory and misuse of corporate funds by the COO.
2-10 Gateway Hospital Behavioral ethics considerations in developing a position on unsubstantiated expense reimbursement claims.
Case # Case Name/Description
3-1 The Parable of the Sadhu Classic Harvard case about ethical dissonance and the disconnect between individual and group ethics.
3-2 Amgen Whistleblowing Case Whistleblower’s termination after raising issues about the company’s underreporting of complaints and problems with pharmaceutical drugs.
3-3 United Thermostatic Controls Acceptability of accelerating the recording of revenue to meet financial analysts’ earnings estimates and increase bonus payments.
3-4 Hewlett-Packard Use of false and fraudulent means to obtain confidential information from members of the board of directors.
3-5 IRS Whistleblower and Informing on Tax Cheats Ethics of gathering sensitive information about wrongdoing to qualify for whistleblower payouts.
3-6 Bennie and the Jets Ethical and professional obligations in reporting accounting wrongdoing to higher-ups in the organization.
3-7 Exxon-XTO Merger Alleged breach of fiduciary duties of the board of directors of XTO Energy that arose from ExxonMobil’s takeover of XTO.
3-8 Disclosure of Steve Jobs’s Health as Apple CEO: A Public or Private Matter? Shareholder rights to receive negative information about the health of its CEO.
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3-9 Bhopal, India: A Tragedy of Massive Proportions Evaluation of the decision-making process before, during, and after the leak of a toxic chemical that killed or injured thousands.
3-10 Accountability of Ex-HP CEO in Conflict of Interest Charges Sexual harassment charges stemming from conflict of interest between CEO/board chair and outside contractor.
Case # Case Name/Description
4-1 America Online (AOL) Internet-based company’s improper capitalization of advertising costs and the use of “round-trip” transactions to inflate revenue and earnings.
4-2 Beauda Medical Center Confidentiality obligation of an auditor to a client after discovering a defect in a product that may be purchased by a second client.
4-3 Family Games, Inc. Ethical dilemma for a controller being asked to backdate a revenue transaction to increase performance bonuses in order to cover the CEO’s personal losses.
4-4 First Community Church Misappropriation of church funds and subsequent cover-up by a member of the board of trustees.
4-5 Lee & Han, LLC Alteration of work papers and ethical obligations of auditors.
4-6 Gee Wiz Ethics of working for employer’s customer on the side and evaluating the customer’s receivable account.
4-7 Family Outreach Questions about validity of expense accounts and ethical obligations of the state auditor.
4-8 HealthSouth Corporation Manipulation of contractual allowances to overstate net revenues, and auditors’ inability to gather the evidence needed to stop the fraud.
4-9 Healthcare Fraud and Accountants’ Ethical Obligations Stakeholder considerations and ethical obligations upon discovering Medicare fraud.
4-10 Independence Violations at PwC Investigation of PwC independence procedures after self-regulatory peer review fails to identify violations.
Case # Case Name/Description
5-1 Computer Associates Audit committee’s role in identifying premature revenue recognized on software contracts.
5-2 ZZZZ Best Fraudster Barry Minkow uses fictitious revenue transactions from nonexistent business to falsify financial statements.
5-3 Imperial Valley Thrift & Loan Role of professional skepticism in evaluating audit evidence on collectability of loans and going concern assessment.
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5-4 Audit Client Considerations and Risk Assessment Risk assessment procedures prior to deciding whether to submit a competitive bid for an audit engagement.
5-5 Krispy Kreme Doughnuts, Inc. “Round-trip” transactions used to inflate revenues and earnings to meet or exceed financial analysts’ EPS guidance.
5-6 Dunco Industries Role and ethical responsibilities of accounting professionals in assessing the validity of audit evidence.
5-7 First Community Bank Valuation of loan loss impairment and risk assessment.
5-8 Fannie Mae: The Government’s Enron Comprehensive case covers manipulation in four areas to project stable earnings—derivatives, loan fees, loan loss reserves, and marketable securities.
5-9 Royal Ahold N.V. (Ahold) U.S. subsidiary of a Dutch company that used improper accounting for promotional allowances to meet or exceed budgeted earnings targets.
5-10 Groupon Competitive pressures on social media pioneer leads to internal control weakness and financial restatements.
Case # Case Name/Description
6-1 SEC v. Halliburton Company and KBR, Inc. Bribery allegations against Halliburton and the application of the Foreign Corrupt Practices Act (FCPA).
6-2 Con-way Inc. Facilitating payments and internal control requirements under the FCPA.
6-3 Insider Trading and Accounting Professionals Insider trading by accounting professionals and providing tips to friends.
6-4 Anjoorian et al.: Third-Party Liability Application of the foreseeability test, near-privity, and the Restatement approach in deciding negligence claims against the auditor.
6-5 Vertical Pharmaceuticals Inc. et al. v. Deloitte & Touche LLP Fiduciary duties and audit withdrawal considerations when suspecting fraud at a client.
6-6 SEC v. DHB Industries, Inc., n/k/a Point Blank Solutions, Inc. SEC action against independent directors and audit committee members in a securities fraud case.
6-7 Livingston & Haynes, P. C. Evaluation of ordinary negligence, gross negligence, and fraud in a securities violation.
6-8 Kay & Lee LLP Auditor legal liability when foreseen third party relies on financial statements
6-9 Reznor v. J. Artist Management (JAM), Inc. Legal liability of manager of lead singer of Nine Inch Nails based on allegations of mismanagement.
6-10 SEC v. Zurich Financial Services Complex accounting for reinsurance transactions and transfer of economic risk.
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Case # Case Name/Description
7-1 Nortel Networks Use of reserves and revenue recognition techniques to manage earnings.
7-2 Solutions Network, Inc. Use of the Fraud Triangle to evaluate management’s actions.
7-3 Cubbies Cable Differences of opinion with management over whether to capitalize or expense cable construction costs.
7-4 Solway, Inc. Use of year-end accruals to manage earnings and whistleblowing considerations.
7-5 Dell Computer Use of “cookie-jar” reserves to smooth net income and meet financial analysts’ earnings projections.
7-6 Sweat Construction Company Pressure on the controller to ignore higher estimated costs on a construction contract to improve earnings and secure needed financing.
7-7 Sunbeam Corporation Use of cookie-jar reserves and “channel stuffing” by a turnaround artist to manage earnings.
7-8 Diamond Foods Link between projecting financial results and earnings management.
7-9 The North Face, Inc. Questions about financial structuring and revenue recognition on barter transactions to achieve desired results.
7-10 Vivendi Universal Improper adjustments to EBITDA and operating free cash flow by a French multinational company to meet ambitious earnings targets and conceal liquidity problems.
Case # Case Name/Description
8-1 SEC v. Siemens Aktiengesellschaft Bribery committed by a German company, using slush funds, off-book accounts, and business consultants and intermediaries to facilitate illegal payments.
8-2 Parmalat: Europe’s Enron Fictitious accounts at Bank of America and the use of nominee entities to transfer debt off the books by an Italian company led to one of Europe’s largest fraud cases.
8-3 Satyam: India’s Enron CEO’s falsification of financial information and misuse of corporate funds for personal purposes.
8-4 Royal Dutch Shell plc Overstatement of estimated recoverable proved oil and gas reserves by Dutch-U.K. company in violation of SEC regulations.
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8-5 Autonomy Investigations by U.S. SEC and UK Serious Fraud Office into accounting for an acquisition of a British software maker by Hewlett-Packard (HP).
8-6 Olympus Major corporate scandal in Japan where Olympus committed a $1.7 billion fraud involving concealment of investment losses through fraudulent accounting.
Major Cases
Chapter Coverage Case Name/Description
1 Adelphia Communications Corporation SEC action against Deloitte & Touche for failing to exercise the proper degree of professional skepticism in examining complex related-party transactions and contingencies that were not accounted for in accordance with GAAP.
2 Royal Ahold N.V. (Ahold) Court finding that Deloitte & Touche should not be held liable for the efforts of the client to deprive the auditors of accurate information needed for the audit and masking the true nature of other evidence.
3 MicroStrategy, Inc. SEC action against MicroStrategy for improper revenue recognition of accounting for multiple deliverables contracts and questions about independence of PwC.
4 Cendant Corporation SEC action against Cendant for managing earnings through merger reserve manipulations and improper accounting for membership sales, and questions about the audit of Ernst & Young.
5 Navistar International Confidentiality issues that arise when Navistar management questions the competency of Deloitte & Touche auditors by referring to PCAOB inspection reports and fraud at the company.
6 Waste Management Failure of Andersen auditors to enforce agreement with the board of directors to adopt proposed adjusting journal entries that were required in restated financial statements.
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xvi
1 Ethical Reasoning: Implications for Accounting 1
2 Cognitive Processes and Ethical Decision Making in Accounting 54
3 Creating an Ethical Organization Environment and Effective Corporate Governance Systems 91
4 AICPA Code of Professional Conduct 175
5 Fraud in Financial Statements and Auditor Responsibilities 246
Brief Contents 6 Legal, Regulatory, and Professional
Obligations of Auditors 335
7 Earnings Management and the Quality of Financial Reporting 410
8 International Financial Reporting: Ethics and Corporate Governance Considerations 475
MAJOR CASES 542
INDEXES 579
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